Market players believe that after the G20 meeting in Shanghai in February 2016, there has been an implied agreement among the central banks to avoid using monetary policy to determine the exchange rates. This has led to the comparative stability across G4 exchange rates.
The statement issued by the Fed Chairman, Janet Yellen, “the spill over effects through exchange rate changes are an important factor in designing monetary policy”, along with the reluctance of the Bank of Japan & ECB to push for very aggressive policies with regard to negative interest rates post the G-20 summit and the comparative lack of turbulence in the global FX markets, strengthened this belief.
It is not easy to prove that such an accord does exist, while some experts believe it is also not relevant.
On the other hand, China’s transformation to a basket-peg and its critical role in the Group of 3 (Japan, the EU, and the US) trade-weighted exchange rate indices could theoretically provide the similar impact as a currency pact.
The influence of China’s transformation to a basket peg regime on its monetary policy has been monitored closely by international policymakers. However, not much attention has been given to the impact of the move on the trading partner’s monetary policy.
For e.g., if the Fed tries to estimate the movement of interest rate normalization prior to December 2015 (at that time the yuan (CNY) was almost fixed to the dollar). A critical consideration would have been the appreciation in the trade-weighted dollar index due to a rise in the Fed Funds Rate (FFR).
This is based on the weight in the dollar trade-weighted index of the nations whose exchange rates are fixed to the dollar. Since CNY’s weight in the dollar basket is significantly higher, it must hold the burden of the dollar appreciation.
However, this mathematical equation changes if the CNY is fixed to the trade-weighted basket in China instead of the dollar.
Under such a scenario, any depreciation of the CNY would increase the appreciation of the dollar basket and vice versa.
It would be difficult to establish if the considerations have been a part of the monetary policy decisions by the G4 central banks. Experts believe the G4 monetary policy would mainly be guided by regional considerations.